Pay off auto loan or invest in Munis

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Pay off auto loan or invest in Munis

Postby newpup » Tue Jul 16, 2013 11:26 am

Hi all-

I have an auto loan at Pen Fed at 1.49% originated in Dec. 2012 which I could now pay off. Should I do that, or invest in Vanguard California intermediate muni (VCADX) yielding 2.42%? I have been keeping a lot of dry powder waiting for a stock market correction, and shockingly my market timing strategy is not paying off. :oops:

Thoughts?
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Re: Pay off auto loan or invest in Munis

Postby MN Finance » Tue Jul 16, 2013 11:30 am

Not comparing apples to apples, but if you're ok with the interest risk of an intermediate fund, then certainly the current yields will put you ahead by investing. That said, your expected return on the fund is not the current yield but rather the aggregate YTM of all the bond holdings, which will be less than the current yield. Given that unknown YTM, your net gain is probably minimal over the debt, and I'd rather not have an auto loan at all, so would pay it off.
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Re: Pay off auto loan or invest in Munis

Postby ogd » Tue Jul 16, 2013 12:56 pm

MN Finance wrote:Not comparing apples to apples, but if you're ok with the interest risk of an intermediate fund, then certainly the current yields will put you ahead by investing. That said, your expected return on the fund is not the current yield but rather the aggregate YTM of all the bond holdings, which will be less than the current yield. Given that unknown YTM, your net gain is probably minimal over the debt, and I'd rather not have an auto loan at all, so would pay it off.

The 2.42% figure that the OP quoted is the SEC yield, which is the yield to maturity of all the bond holdings. It's indeed a little hard to believe that figure after you add in the tax savings.

newpup: I do the same with an auto loan at ~1% that I intentionally keep on the books. Since it's below inflation, I consider that loan "free money" -- well, not really, we all know this is coming from the price of the car :) (edit: ah, yours probably isn't) but we've paid that already and enjoy what it got us.

This all depends on your confidence in managing your finances and in your income stream. It may well be that the munis lose a bunch and the auto loan forces you to sell at a bad time. On the other hand, the loan provides extra liquidity since you won't be able to borrow at 1.5% on a whim in the future. Overall I would say it makes financial sense by the numbers; it doesn't gain you a lot since these loans are relatively short-term and small vs something like a mortgage; and it's ultimately a gut call. Hope this helps!
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Re: Pay off auto loan or invest in Munis

Postby G-Money » Tue Jul 16, 2013 1:13 pm

What ogd said.

As long as you're OK with the maturity of your loan constantly declining while the average maturity of your bond fund remains constant (so they won't precisely match and will become increasingly disparate), go for it. Alternatively, you could look for CDs with maturities around 12/2012, although they probably will pay less than 2.42% after tax (but with less risk).
Don't assume I know what I'm talking about.
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Re: Pay off auto loan or invest in Munis

Postby grabiner » Wed Jul 17, 2013 7:42 pm

newpup wrote:I have an auto loan at Pen Fed at 1.49% originated in Dec. 2012 which I could now pay off. Should I do that, or invest in Vanguard California intermediate muni (VCADX) yielding 2.42%?


You should pay off the loan, because this has less interest-rate risk. If the PenFed loan is a 5-year loan, then paying it off now has a 2-year duration (the time-weighted average of the future payments), and the return is a tax-free 1.49%. The most comparable Vanguard muni fund is Limited-Term Tax-Exempt, which has a yield of 0.86%.

If you would like to get higher returns by increasing your interest-rate risk, you can do that for a lower cost while paying off the loan. You could shift some of your existing bond holdings to a longer-term fund (CA Intermediate-Term Tax-Exempt to CA Long-Term Tax-Exempt, Total Bond Market to Long-Term Bond Index, Inflation-Protected Securities to the LTPZ ETF which holds long-term TIPS).
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Re: Pay off auto loan or invest in Munis

Postby Watty » Wed Jul 17, 2013 9:25 pm

At some point the difference becomes so small that it is not worthwhile, especially since something could go wrong like a default on a Muni or the car gets wrecked and you have to use the insurance money to pay off the car loan.

If you are talking about $20,000 and the difference is 2.42-1.49 = 0.93% or all of $186 a year.

You could split the difference and pay off the car, but invest your "car payment" each month in whatever asset allocation is appropriate for overall portfolio which might have a higher expected return then the Munis.
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